Last Thursday, we started our post-spring break Tax Policy Colloquium final stretch run with Emmanuel Saez's "Details Matter: The Impact of Presentation and Information on the Take-Up of Financial Incentives for Retirement Saving." The paper analyzes a large-scale real world field experiment with H&R Block in St. Louis several years back, in which randomly selected but generally lower-income customers were offered a cash incentive for establishing an IRA account with Block. Some got no incentive, a second group got a 50% match (e.g., put in $600 and Block would add $300 to the account), and a third group got a 33% credit (e.g., put in $900 and Block would send you a check for $300).

Take-up of the IRAs was generally low, even though the two incentive plans offered free money given that, despite early withdrawal penalties, one would come out ahead if one closed the account in a year. This point was not emphasized, however, and the low take-up even with incentives reinforced the difficulty of encouraging what we might think is optimal retirement saving by lower-income workers. (Either that, or else they perhaps rightly didn't like this particular savings vehicle, which had high annual fees relative to value for small accounts.)

The main finding of the study was that the match proved more popular than the credit, even though, as the above example shows, they are arithmetically equivalent IF putting down more cash now (typically out of one's refund) and waiting two weeks for a check that one then has to cash is assumed to be cost-free.

In part, people seem to have responded to the nominally larger size of a 50% match compared to a 33% credit, even though they're actually identical since the base for computing the percentages differs as between the two of them. But there's also some reason to think that people like the match structure better than the credit structure even when they're effectively identical. My proposed explanation was that the match looks like free money, while the credit looks simply like a price break, which still leaves the question of whether the price is good enough to justify a purchase. Or, hyperbolic discounting could be doing the work if people think of the match as immediately effective (though in fact it takes a couple of weeks, and one is saving the money in the account anyway) and the cash back as in the future. Neither of these is a rational explanation, of course.

I more generally wonder to what extent incentives (at least relative to applying the regular income tax treatment of saving) can generate the sort of retirement preparation that we believe is in most cases optimal. One is appealing to rational calculation in a setting where it's generally thought not to work so well. Beyond the use of defaults so people have to opt out of retirement saving, I think the better answer lies in a Social Security-style mandatory approach(government takes money from you now and gives it back with interest later, or else simply makes you wait for transfers later). This isn't perfect either (e.g., as Louis Kaplow notes, it can affect work incentives, given the preference for immediate consumption, even if one demonstrably gets fair value back). But I see it as more promising than the income-conditioned saver's credit or match approach that motivated the Saez experiment.

From an ABC News story on AIG renegade executive Joseph Cassano, the infamous head of their Financial Products Division:

"Cassano set up some dozens of separate companies, some off-shore, to handle the transactions, effectively keeping them off the books of AIG and out of sight of regulators in the U.S. and the United Kingdom.

"'This is the other very important issue underneath the AIG scandal,' said Blum. 'All of these contracts were moved offshore for the express purpose of getting out from under regulation and tax evasion.'"

This is pretty much the point Mihir Desai makes in his work on taxes and corporate governance. Once there is a planning excuse for complex structures, they can be used for multiple nefarious purposes, e.g., tax fraud, avoiding internal and market as well as formal regulatory oversight, looting the company, etcetera.

Complex structures kill transparency. At the limit, they make corporate governance impossible and genuinely profitable activity by publicly traded companies a pipe dream. To some extent, this is a problem of financial not "real" activity, as the latter is much easier to observe. E.g., Apple Computers and General Motors both are presumably well-judged by the market because to a considerable extent one can see how well or poorly they are doing. But even companies engaged in real productive activity often have such large finance wings (think GMAC historically, or GE's recent problems) that the virus of non-transparency extends well beyond the pure banking and finance sector.

Tuesday, March 24, 2009

The head of China's central bank is now calling for the dollar to be dethroned as the world's reserve currency and replaced by a new IMF-controlled benchmark.

I doubt anything will come of this right away, and if I were the Chinese I might not even want immediate adoption of this proposal (which could devalue their vast dollar holdings), but this may well be the way we are headed. The U.S. has simply been over-exploiting the economic value of being the reserve currency, and at some point the golden calf perishes, so to speak.

My guess is that the Chinese are trying to scare us into taking more responsible measures so as to head off this kind of scenario. It's a tricky game, since until they've lowered their dollar holdings they don't really want to scare the world's investors more than they scare us - it has to be the other way around for them to benefit. But the fact that they are doing this shows how concerned they understandably are. And I don't know how responsive political constraints will permit U.S. policymakers to be, though I don't doubt that high-up Obama Administration officials have heard and understood the message.

Monday, March 23, 2009

My family went site-seeing in Washington D.C. while I was going to a conference at the Washington University in St. Louis. Conceptual togetherness even when apart? They returned with this lovely photo, which they rightly surmised that I would enjoy.

On the same theme, I got to talk while at WULS with a former senior economist in the Nixon and Reagan Administrations, a very nice and interesting man. At lunch one day, I couldn't resist asking him about Nixon. He said Nixon was exceptionally intelligent but a strange person with an overwhelming aversion against ever taking the simple, direct, straightforward route to any objective. For example, if there was a public document to release, Nixon would insist on leaking it somehow as a means of rewarding friends in the media or punishing foes. Reagan, he said, was very pleasant but clearly regarded everyone working for him in the government (even people as high up as Jim Baker) as hired hands - you could see the contrast when Jimmy Cagney and Patrick O'Brien came in for a White House film screening and were greeted very differently.

Saturday, March 21, 2009

I am sitting in a hotel lounge (better-appointed than the available ones at the airport) waiting for the departure time of a flight out of St. Louis, where I just spent the last two days at a budget conference organized by Cheryl Block of WULS. Lots of interesting sessions, on topics ranging from automatic budgetary changes (such as entitlements cuts) to restore fiscal sustainability, to how the Presidential and legislative budget processes do and should function (e.g., use of budget resolutions or automatic sunset rules), to the practical political feasibility of "saving" Social Security surpluses, to the relevance of the tax expenditure debate, to issues of capital budgeting (amortizing items with long-term benefit) and how to measure the budgetary cost of bailouts.

I was there to present my current paper on the fiscal gap, its generational equity and efficiency consequences, etc. I'll probably get to rewrite this paper, using more recent CBO estimates and changing the emphasis a bit, as Cheryl is planning to create a conference volume, or perhaps something better than a conference volume in that it emphasizes organizing new knowledge without being limited to what people happened to present.

One thing that became clear to me in re. my paper is that the financial crisis has opposite implications for the apparent relevance of my paper than I realized when I started writing it. As I noted in a prior post about someone's colloquium paper, it can be kind of awkward or inconvenient when current events, such as the financial crisis, overtake one while one is writing a given paper (e.g., if one is lauding universal home ownership). When the financial crisis hit while I was in mid-draft, I had a bit of the feeling that it was rhetorically inconvenient because the short-term emphasis has to be on pulling the economy out of its nosedive, rather than immediately restoring long-term balance. So while I could rightly point out in my draft that the financial crisis makes the long-term problems worse, I had to acknowledge that the current mess has to be dealt with first.

But especially in lieu of the Chinese prime minister's recent remarks about U.S. solvency, it became clear to me (perhaps with a little help from my friends) that the positive links between the two issues are stronger than I had recognized. If you're going to be borrowing $2 trillion a year for the next few years, you had damn well better take steps to reassure prospective lenders that you are on a course to assure your own long-term solvency.

One way of putting it is that the Washington MSM conventional wisdom, as usual, is 180 degrees wrong. Obama isn't tackling too much - healthcare and energy policy/ cap and trade permits are actually even more urgent given the crisis than they would be otherwise. Rather, he is tackling too little, in that he hasn't done enough so far to show that the U.S. will be trying to tack back towards the path of solvency. Which is not to say that his or his advisors' political judgment was wrong if they concluded this would be unfeasible. But certainly in terms of the correct policies to follow, by failing to address long-term solvency sufficiently yet (apart from a couple of tantalizing hints), one could argue that he needs to put more on his plate, not less.

I now feel a bit more knowledgeable about the AIG bonus situation than the last time I posted about it, so here are some follow-up thoughts:

1) Words sure matter. If they hadn't called these things "bonuses," obviously no trouble. The underlying situation seems to have been as follows. These guys were getting what I'd call fake or misdirected incentive compensation. Fake in that, as we actually learned in the event, if the payoff from the incentive payments disappeared they would simply be compensated in some other way instead. So to a degree it was, as usual, "heads we win, tails you lose." Once there were no profits from their trading to share they simply got paid a flat fee instead. That said, I gather the salary cut they got was more than 50%, so there wasn't zero "incentive" element. But of course the incentive was misdirected even insofar as they actually faced variance, since the profits they shared in were akin to that from insuring 100% of New Orleans' hurricane risk before Katrina and hence taking home lots of money each year until it hit, whereupon the company got wiped out without actually being able to pay on its customers' insurance claims. Not a great incentive structure to induce people to pretend for a while the company is making money through these things.

2) Given the fixed pay they were receiving in lieu of "incentive" pay, there really was a retention element. Specifically, rather than getting paid more regularly they'd have to stay around for several months at a time in order to get their pay for the period only when it was over. So in that sense it wasn't really a bonus, so much as a plan to make them stay on instead of quitting sooner to get the salary they were otherwise earning (which wouldn't otherwise have been called a bonus, hence eliminating the entire political blowup).

3. Why pay these guys to stay? Who'd want them? What could be their opportunity cost of staying given (a) what they had done and (b) the down economy in financial services especially. I gather there actually is a decent answer to this question. While it's hard for me to judge how hard it would have been for someone else to unwind the AIG positions, these guys had economic value to other employers until the unwind was completed, for the simple reason that, having constructed the positions, they knew what the positions were. Someone who wanted to squeeze AIG (or rather the federal government) on the other side of the transactions could have made money off knowing just what the positions were. Or at least so I'm told. So by this light it was prudent to pay these guys something to stick around so they wouldn't quit and use their knowledge to help someone else cash in (along the lines of Long-Term Capital Management, which got hosed in the unwind some years back partly because counter-parties had figured out their positions and knew they had liquidity needs that would make them sell right away for whatever they could get in a thin market.

So there's underlying bad behavior at various levels here, but arguably the bonuses (a) weren't really that and (b) were worth paying from the government's position. Though I should stress that none of this interpretation is based on my own personal & direct knowledge - it comes rather from what I've read and heard, so in legal trial terms it's hearsay.

4. I gather that the blowup over the "bonuses" is already creating extreme reluctance by private parties to participate in ongoing and new government bailout programs that might subject them to similar firestorms in the future. Then again, given the extremely dim view that many have, for example, for Geithner's new bank bailout program (e.g., see Krugman here), maybe that's not as bad as it sounds. Suppose it forced the adoption of better-conceived bailout policies.

5. The 90% tax may conceivably face a serious constitutional challenge notwithstanding Larry Tribe's assurances to the contrary. Not a surprise, perhaps, as Tribe can be a bit political in his bottom line constitutional judgments. One source of possible trouble could be a NY state case from a few years back, Pataki v. Con Ed, in which a provision denying rate adjustments to the Con Ed shareholders for the blunders that had led to the Indian Point nuclear power plant problems was struck down as a bill of attainder. Obviously, the 90% tax is being drafted with an eye to avoiding the same fate, by causing it to apply more generally. But in the Con Ed case, the court cited legislative history showing that the legislators were specifically angry at Con Ed for its bad deeds and wanted to inflict punishment (hardly unreasonably, but that's not the point when the question of law is bill of attainder). Needless to say, the record of enactment for the 90% tax (if it goes through) is hardly lacking in evidence that the legislators were specifically interested in nailing AIG. Not to say that this is necessarily fatal, and it is presumably being drafted with a keen eye to the problem, but there's precedent for treating the clear intent as adverse evidence on the constitutionality question.

Wednesday, March 18, 2009

On the tennis court recently, I had been playing very well, then I lost my strokes and floundered horribly for a couple of sessions, then I was able to find them again and played very well this week.

The analogy that seems utterly compelling to me is that of a computer file somewhere in your system that you need to locate and access quickly in order to run a particular program in real time. Maybe with the additional detail that it needs to be on your "Recent Applications" list in order for you to find it effectively. But one couldn't have conceptualized it this way until PCs came into common usage.

Tuesday, March 17, 2009

I was angered by the AIG bonuses. Sure, it's a bit of a pop symbolism issue, but I found it odious that these Typhoid Marys of finance - who ought to be unemployable for life, other than asking if you want fries with that, after all that they've done to their shareholders and the world economy - should get all those million dollar bonuses out of federal money, supposedly so they won't leave, when some already have and the rest probably should. Plus my anger reflected my belief that over-the-top executive compensation, as it's developed in the last decade, has not just been wasteful and misguided, but a primary cause of the global economic disaster. Burning the money would have been better for the U.S. and world economy than letting the people in these sorts of positions "earn" it by pulling monkeyshines that involved phony income plus all too real downside economic risk.

But a 100% "tax" on a specific group of individuals with respect to items paid before enactment of the "tax" certainly makes me uneasy. (Scare quotes because - though I am no constitutional law expert - the narrowly targeted 100% rate seems to put it on the wrong side of the amorphous line between a tax and a Fifth Amendment taking.)

Frankly, it doesn't bother me in the slightest if the 100% tax applies just this one time to just these people. They would appear to deserve it many times over. But one can never be sure that one isn't creating a precedent with legs. Might the device someday be used against someone else who just happens to be unpopular?

I'd actually like to make an example of these guys - as the French would say, "pour encourager les autres," as well as for general public morale. But I'd prefer a better way of doing it, such as investigating them for looting and fraud, which might have been amply justified even without the bonuses.

Friday, March 13, 2009

"The Chinese prime minister, Wen Jiabao, spoke in unusually blunt terms on Friday about the 'safety' of China’s $1 trillion investment in American government debt, the world’s largest such holding, and urged the Obama administration to offer assurances that the securities would maintain their value.

"Speaking ahead of a meeting of finance ministers and bankers this weekend near London to lay the groundwork for next month’s Group of 20 summit meeting of the nations with the 20 largest economies, Mr. Wen said that he was 'worried' about China’s holdings of United States Treasury bonds and other debt, and that China was watching economic developments in the United States closely....

"In January, Mr. Wen gave a speech criticizing what he called an 'unsustainable model of development characterized by prolonged low savings and high consumption.' There was little doubt that he was referring to the United States."

Yesterday we had our ninth session of the year, and last before spring break, discussing the above article by David Duff, who has long been at the University of Toronto Law School but is moving to the University of British Columbia Law School, in Vancouver. (In weather terms, this is a bit like trading Boston for Seattle, which sounds pretty good to me after the 3-and-counting monstrously brutal winter months that we've had here in New York.)

The paper posits that different fairness norms apply to different elements in the tax structure. On reading the paper, this struck me as requiring one to deny or disregard the fungibility of money. But, as often happens at the colloquium lunches in advance of the sessions, we discerned that he actually meant something a bit different.

David classifies himself in philosophical terms as a liberal egalitarian, opposed to the welfarist and libertarian traditions, but he disclaims what at times can be the vindictive face of liberal egalitarianism - its suggestion, in some proponents' hands, that we should turn our backs on people who have made mistakes, rather than trying to help them out, because somehow this "respects" them more as moral agents. I personally am quite willing to suffer "disrespect" in the form of compassionate rescue if I ever need it. Another occasional implication of liberal egalitarianism that he disclaims is that equalizing opportunity downward is just as good as doing so upward. (This led to the retort at one conference I once attended that the best possible way of implementing equal opportunity is through global thermonuclear war - then we'd never have to worry again about some people having better opportunities than others.) What he does mean by liberal egalitarianism, however, was less clear - though this was partly our fault not his, because as usual we didn't get to the phantom "Topic 3" on our discussion list.

The paper perplexed me a bit by arguing that, wholly without regard to distributional issues, a VAT with an exemption amount would be the right way to pay for public goods. To me, it would seem that the only reason for having high earners pay more than low earners is distributional. David gets there by following Blum and Kalven to the effect that we should totally ignore benefit from public spending and pretend it was wasted, for purposes of deciding who should pay. He then argues for equalizing individuals' total sacrifice, as a loosely libertarian-style privileged baseline - from which (unlike the libertarians) he would then be willing to redistribute as well, but in his mind through a fundamentally different exercise.

I argued in response, inter alia, that "total sacrifice" is incoherent. E.g., just because we can't measure benefits going the other way doesn't mean that we should counter-factually pretend that they're zero. More generally, there simply is no meaningful baseline of "public goods without financing" - his revision to the libertarians' supposed state of nature - from which to measure total sacrifice. Nor would I find the exercise normatively motivated even if I thought it was coherently definable. But to each his own, and one need not always agree to have a civil and productive discussion.

Followers of my cats will be glad to hear that Ursula, knock on wood, is doing a lot better. She's overcome her kidney infection and now just needs a couple of water shots a week. She's silky and active as ever, and has a better appetite than she's had for months if not years.

Ursula is cautious and doesn't like strangers, but it's nice to be one of her favorites. If she hears me on the floor exercising (attempting to stave off the 6 main injuries I periodically get from playing tennis), she will come up, purring and fluttering, rolling on the floor, bashing her head against my hand, leg, or head, etcetera. She also seems to really like it when I shave - perhaps the electric shaver sounds as if I'm purring.

She's remarkably astute about figuring out when I'm on the verge of grabbing her for a water shot. Turn your head for one second and she's gone. Luckily, she only has about 5 main hiding places. Once I get her, she simply issues a piteous mew and shrinks down, rather than fighting, but with her heart beating madly. There are no hard feelings afterwards, however.

Shadow, at age 18, is not doing so well as Ursula at age 7. At this point he has diabetes, kidney disease, an ear infection, and either hyper- or hypo-thyroidism, each requiring extensive treatment that he bears in good spirit. He has little appetite or energy, and his litter box consistency has disastrously declined, but he still has one of the great temperaments I have ever known from an individual of any species. I fear we are in the endgame with him, and that is generally not pretty.

Wednesday, March 11, 2009

At one point during my book session at the Urban Institute today, I made the comment that, just as the SEC sometimes makes companies restate past years’ income which turns out to have been partly sham, so maybe the U.S. should have to restate GDP for the last few years. Think about it – the financial sector was nominally producing 8% of the total, and much of this appears in retrospect to have been wealth transfers unaccompanied by the actual performance of services or creation of value.

E.g., suppose a firm made tons of money by purporting to insure 100% of New Orleans’ hurricane risk. The premiums go into GDP on the view that they are not just transfer payments but reflect the value of the insurance. Then Katrina hits and the firm goes bust since it’s totally unable to cover the undiversified risk. Was there ever really national income from the insurance premiums, or was this (take your pick) theft or the equivalent of a transfer payment?

That, of course, is basically the story of AIG. “We didn’t know a hurricane would actually hit New Orleans – our climate model, based on the previous 5 years’ results, showed no severe hurricanes in New Orleans whatsoever.”

OK, I’m engaging in a bit of snark here, not to mention argument by anecdote. But the underlying point is a serious one. Think of all the CDOs that were being swapped around for billions of nominal dollars. There was perhaps some genuine value creation mixed in there – diversifying within mortgages and creating risk tranches wasn’t entirely worthless – but due to the bubble economy the market prices grossly outweighed the actual value creation.

If there’s one thing we try to avoid in measuring GDP, it is making subjective evaluations of value rather than simply looking at prices and transactions. But what ultimately matters is the subjective underlying stuff – the actual creation of things people value. If there’s one thing we’ve learned in the bubble economy of the last few years – other than the facts that transparency is far lower and managerial incentive problems far graver than we realized – it is that prices really can go far, far away from the underlying subjective fundamentals that we care about.

I don’t, of course, seriously propose that we restate past years’ GDP. But it’s important to keep in mind that, even before the crash hit, we were not as rich as we thought we were, and in judging this conventional economic measures can lead us far astray.

This morning, I attended a book event at the Urban Institute discussing my corporate tax book. Good crowd, maybe about 80 people, apparently plus a webcast audience. My PowerPoint slides for my portion of the event are available here.

Greg Ip of the Economist was the moderator, and the discussants were Rosanne Altshuler of Urban/Rutgers Economics, Dan Halperin of Harvard Law School, and Pam Olson of Skadden Arps (formerly Assistant Secretary of the Treasury for Tax Policy).

While the discussants naturally focused on the policy proposals I make at the end of Decoding, I mainly devoted my comments to an overview of the whole thang, as I believe its main and most enduring value relates to the broad question of how one should think about and understand the corporate tax.

Rosanne emphasized the difficulties of deciding where to head in U.S. international taxation as between the worldwide and territorial approaches, and noted that her burden-neutral proposal (with Harry Grubert) to repeal deferral, which I propose to extend to foreign tax credits as well, needs a lot more fleshing out than any of us have given it as yet. She also noted the importance of the U.S.’s having an usually high marginal corporate tax rate by worldwide standards, even if our effective rates are considerably more within the norm.

Dan made an excellent point that the book at least rhetorically underplays a bit, namely that many of the problems raised by corporate integration would apply as well to lowering the U.S. corporate rate. For example, effects on debt-equity choices, the use of corporate tax preferences, and whether we want to use the corporate tax in order to impose an indirect levy on tax-exempts such as Harvard University (his example) really are common to both. This leaves, however, the difference that lowering the entity-level rate applies to inbound investment by foreign corporations, and affects incentives to transfer-price international income into, as opposed to out of, the United States.

Pam addressed corporate governance issues and book-tax conformity in income measurement. While she questioned my exact proposal (50% conformity between taxable income and an adjusted measure of book income), she joins what I think is a growing consensus (at least outside the accounting profession) that the gap between companies’ book and taxable income is too troubling to be dismissed with the airy statement that, gee, the two systems are just different.

Greg asked me about a comment I had made in chat before the start to the effect that I questioned the Obama Administration’s budgetary claim to have $200 billion of revenue to be garnered out of “reforming” deferral by U.S. multinationals. I explained that I was skeptical that the money will turn out to be there either as a matter of legislative politics or straight revenue-raising, and that it’s questionable how much more money we can try to get out of U.S. multinationals when the underlying thing we are taxing – the decision to classify one’s investments as made through a U.S. corporate resident – is so trivial and, over the long term, easily changed.

Friday, March 06, 2009

Yesterday's discussion returned to more traditional law school tax policy fare, concerning corporate integration and the Bush Administration's partly failed 2003 attempt to accomplish it via dividend exemption. Michael's thesis in his paper is that the political economy story developed in prior work, such as the well-known article by Jennifer Arlen and Deborah Weiss, needs to be revised. Arlen-Weiss emphasize agency costs, in the form of managers not really caring about the transition windfall to shareholders that unanticipated adoption of dividend exemption would provide, and preferring instead to get incentives for new investment plus an excuse not to incur tax burdens by making dividend distributions.

I like the Arlen-Weiss paper, though my views differ a bit in emphasis since I give greater relative importance to (a) the "populist" problem of people thinking that corporations are "people" and should pay tax plus shareholders are wholly separate people and should also pay tax, plus (b) the interest group problem in which managers are aligned with shareholders to prefer targeted tax breaks for their own industries rather than a general corporate-sector improvement in tax treatment. [Actually, diversified shareholders might rationally prefer general corporate tax reform after all, but as shareholders of a given company their interests arguably are aligned with managers regarding targeted giveaways.] But this isn't a big disagreement, just a difference in shading or emphasis.

Anyway, Michael posits that the Arlen-Weiss story is too simple [note: Jennifer Arlen might not agree with how her story is characterized] and needs to be overhauled to give much more pride of place to the issue of heterogeneity. Lots of different players are affected by corporate integration in different ways. E.g., for a given integration proposal, those in some industries might be aided while others are hurt, depending on differences in industry, effective tax rate, shareholder clientele base, etc. Michael reviews the 2003 story, and sees it as all about heterogeneity creating gridlock, rather than the managers defecting from being the shareholders' faithful agents.

As lead commentator, Alan Auerbach emphasized that heterogeneity exists on all sorts of issues yet legislation happens, and presumably exists worldwide with respect to corporate integration yet it has frequently happened everywhere else around the world (albeit that it's been in retreat lately in Europe due to EU problems). So why is this issue special and why is the U.S. different on this issue?

Further discussion pushed us (or at least me) towards the view that the 2003 issue is a bit of a simpler story (and less of a change to Arlen-Weiss) than generalized heterogeneity. The 2003 dividend exemption would have been a substantial blow to the value of corporate tax preferences because it only offered dividend exemption to previously taxed corporate income. This meant that, if you used tax preferences to avoid corporate-level tax, you would get hit at the shareholder level by distributions. Companies that use lots of tax preferences (such as the low-income housing credit) screamed bloody murder and got House Ways and Means Chair Thomas on their side, whereupon it was game over. The proposal went to a 15% rather than a 0% dividend rate, and the feature requiring previous corporate-level tax payment on the distributed income disappeared.

As a general matter, I happen to like reducing the value of corporate-level tax preferences. But it seems clear that, due to this feature, the 2003 dividend exemption was not pure corporate integration. It was corporate integration PLUS corporate-level base-broadening. A pure corporate integration approach would have been "ceasefire in place" regarding the value and usefulness to taxpayers of corporate-level preferences. It's no big surprise that base-broadening faces heavy political obstacles, so what we really had in 2003 was a standard interest group story, much more than a broader heterogeneity story about corporate integration or dividend exemption in general.

CLARIFICATION: After sidebar conversations with a reader who disagreed with my apparent statement that "pure" corporate integration means keeping the preferences, I should emphasize that what I meant above is not (a) that "pure" integration means having tax preferences, but rather (b) that, given where we are now, changing the corporate tax rules purely on the integration dimension would mean ceasefire in place as to the tax preferences. Again, I'd greatly prefer corporate integration with smaller tax preferences than with the same ones, but I would then regard myself as having changed two dimensions.

One further interesting point that came up in the discussion concerned the reasons for U.S. exceptionalism with regard to the double corporate tax. People in the audience noted that U.S. shareholding in public companies is much more diversified than, say, in Europe, where family corporations play a much bigger role. So the publicly traded sector in the U.S. does less to fight for corporate integration than it would in the family firm scenario (basically for Arlen-Weiss reasons). But then it was further noted that there are plenty of closely-held businesses in the U.S.; only, they can generally avoid falling into the C corporation tax world, even if they want limited liability for owners, as they can elect to be taxed on a flowthrough basis as S corporations, or can be LLCs that elect to be taxed as partnerships. Other countries don't have the S corporation route as such. So the hypothesis is that the U.S. is less politically unusual than it seems (or rather is unusual only in having a distinctive institutional twist). If this view is correct, we have simply let the closely held firms opt out of the double tax on the side and hence faced less political pressure to let out the rest.

Tuesday, March 03, 2009

Walter Blum, an eminent tax scholar and professor of law at the University of Chicago when I arrived there in 1987 who was also a great mentor to me, used to say to his Tax I class, at the beginning of Day 1, that the Dean had just raised his salary. But the problem was that this would put him in a higher tax bracket. Didn't this mean that he should ask the Dean to rescind the raise?

Wally was a classic (though humane) Socratic-style teacher, so for this to work he had to find someone who would actually get it wrong and believe that the answer was yes, whereupon he could poke gentle fun for a while until the point emerged that this was just the marginal rate on the last dollar he earned - so he'd be ahead after tax from an extra dollar of salary no matter what.

Among the reasons I would never try this myself, in my Tax I class, is that I know I would get the right answer, preventing the gambit from working for me pedagogically as it did for Wally. Given this problem, a Chicago colleague once asked Wally how he made it work. He answered "I just look around the room until I see someone who I know is going to get it wrong." (This at the start of the first class of the semester, mind you.)

Well, apparently Wally was not the only one capable of finding someone who would get the marginal rate question wrong. ABC News found someone as well, and decided to hire her and give her a platform as a reporter on budget issues. Emily Friedman, it's time for your closeup. She has now posted a column guilty of exactly this fallacy, and therefore positing that lots of rich families will respond to the Obama budget plan by trying to drive their incomes below $250,000.

Jon Chait of the New Republic calls this the dumbest news report he's ever seen, admittedly a high standard.

As hilarious as Friedman's bonehead blunder itself is the classic reportorial method she uses to establish it. The article starts with a bunch of interview quotes from people who evidently are guilty of the marginal rate fallacy and are consequently making plans to get rid of clients and patients, etcetera. Then she quotes an expert who discusses the feasibility of getting below $250,000, but then says it won't really matter if you're at $249,999 or $250,001. This is not well explained or picked up on, however. Then Friedman goes with another "expert" who posits that Obama's proposal will lead to class warfare. Finally, back to the bonehead taxpayers who misunderstand how the proposal works, to close with a heart-tugging bit about how they're overtaxed.

In conventional mainstream media terms, the article is fine. After all, it is merely a viewpoint (albeit a true one) that the Obama tax plan would work as it actually works. It is also a viewpoint that it works differently from how it actually works. Friedman names her sources and leads with the ones who are more fun. Even if she knew the right answer, I suppose it wouldn't be "objective reporting" by her lights if she said so.

Last Thursday, we followed our recent once-a-year tradition of having a paper by a political scientist, in this case Leslie McCall of Northwestern & Princeton concerning American public attitudes towards progressive redistribution. Main takeaways: (1) Americans are more redistributive (and less different in this regard from Europeans) than has widely been thought, (2) in general, concern about income inequality grew in the 1990s with actual inequality, and (3) such concern tended not to produce support for more progressive income tax rates or a larger welfare system because people were skeptical about those two institutions. Instead, it was largely channeled into support for education (believed, perhaps erroneously, to lead towards more equal results) and regulatory issues such as immigation, the minimum wage, and CEO pay.

Generally the story was convincing, although there's only limited data (from large-scale surveys undertaken over the last 20 years). Some of the points we made at the session concerned (a) the difference between addressing the rich and aiding the poor in how people in the middle think about inequality, (b) the importance of whether one's own income is rising or stagnant to how one thinks about those who are getting a lot richer, and (c) the lack of any strong reason for expecting, not withstanding the median voter hypothesis, that our political system will produce increased redistribution even if the median voter wants it.

About Me

I am the Wayne Perry Professor of Taxation at New York University Law School. My research mainly emphasizes tax policy, government transfers, budgetary measures, social insurance, and entitlements reform. My most recent books are (1) Decoding the U.S. Corporate Tax (2009) and (2) Taxes, Spending, and the U.S. Government's March Toward Bankruptcy (2006). My other books include Do Deficits Matter? (1997), When Rules Change: An Economic and Political Analysis of Transition Relief and Retroactivity (2000), Making Sense of Social Security Reform (2000), Who Should Pay for Medicare? (2004), Taxes, Spending, and the U.S. Government's March Towards Bankruptcy (2006), Decoding the U.S. Corporate Tax (2009), and Fixing the U.S. International Tax Rules (forthcoming). I am also the author of a novel, Getting It. I am married with two children (boys aged 16 and 19) as well as four (!) cats. For my wife Pat's quilting blog, see Patwig’s Blog.